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The two companies said that AIG has agreed to sell American Life Insurance Co., better known as Alico, for $6.8 billion in cash and $8.7 billion in MetLife equity, including common stock and convertible preferred securities.

Under the deal, AIG would effectively take a stake of about 20% in Metlife, receiving 78.2 million common shares and 6.6 million shares of convertible preferred stock. That makes AIG, which is nearly 80% owned by the U.S. government, the second-largest shareholder of MetLife, which made it through the financial crisis largely unscathed.

A trust currently holds roughly 28% of MetLife's shares on behalf of its insurance policy holders. The common shares to be owned by AIG would represent about 14% of MetLife, and AIG could sell the preferred securities before they are converted into common equity.

AIG's shares in MetLife will come with voting restrictions, preventing it from influencing MetLife's operations and business decisions. But AIG will be exposed to MetLife's fortunes over at least the next nine months to two-and-a-half years, the minimum period for which it has to hold on to the shares. How MetLife's stock performs will determine the value AIG can fetch when it decides to sell off its stake for cash.

MetLife didn't receive government money during the financial crisis, and it competes head to head with AIG's U.S. life-insurance and retirement-services business in several areas, such as fixed and variable annuities and life-insurance policies that are sold to individuals. MetLife will use some of its existing cash and issue new equity and debt securities to help finance the cash portion of its Alico purchase. MetLife expects the deal to boost its earnings by 45 cents to 55 cents a share by 2011. Currently, analysts are estimating MetLife's operating earnings at $4.89 in 2011.

AIG Chief Executive Robert Benmosche, who was previously MetLife's CEO and remains a shareholder, wasn't involved in the deal talks, which were handled by a special committee within AIG.

With the Alico pact, and one inked a week ago to sell its Asian life-insurer unit, American International Assurance Ltd., to
Prudential PLC
for $35.5 billion, AIG now expects to return $32 billion in cash to the Federal Reserve Bank of New York in the coming months, if both deals close as scheduled by year-end.

Another $19 billion is likely to be returned over the next few years when AIG's large stakes in Prudential and MetLife are sold.

Both Prudential and MetLife decided against all-cash deals for AIA and Alico respectively because they were concerned about the impact on their credit ratings and stock prices, said people who worked on the two deals. Executives of both companies quickly realized that their deals with AIG would have to include the rival insurer—and by extension the federal government—becoming a sizable shareholder, the people added. AIG is getting a roughly 11% stake in the U.K.'s Prudential, which isn't linked to Prudential Financial Inc. in the U.S.

The New York Fed, which rescued AIG from bankruptcy in the fall of 2008, has so far spent more than $83 billion supporting the insurance giant, of which $50 billion is to be repaid through AIG asset sales. The other $33 billion is supposed to be recouped from mortgage-linked securities previously held or insured by AIG that are now on the New York Fed's balance sheet.

With AIG now on a path to repayment of its secured loan from the New York Fed in full, government officials and analysts are beginning to contemplate what the U.S. exit strategy from AIG could look like and how it would take shape in the coming years.

The Treasury has also pumped $47 billion into AIG via its Troubled Asset Relief Program, and currently holds its investment in the form of preferred shares. With AIA and Alico sold, AIG's CEO, Mr. Benmosche, has said AIG plans to keep its global property- and casualty-insurance business as well as its domestic life-insurance business at its core. It expects to sell off other assets, such as pieces of its aircraft-leasing firm International Lease Finance Corp., and last week it announced the sale of its remaining stake in reinsurer Transatlantic Holdings. But proceeds from these will be much smaller than what AIA and Alico are fetching.

One idea being mulled by government officials and AIG insiders would involve the Treasury gradually converting small portions of its AIG preferred shares into common shares that they can sell through stock offerings to investors, according to people familiar with the matter. Another alternative is for AIG to issue new shares to the public and use the proceeds to redeem the preferred shares.

Such a "recapitalization" of AIG's balance sheet would have to occur over a period of several years, given that Treasury's $47 billion in preferred shares dwarfs AIG's stock-market capitalization of about $3.8 billion. When most of the taxpayer assistance to AIG is repaid, the government might then reduce its stake in the company, according to people familiar with the matter, who added there isn't a definite exit plan in place yet.

MetLife was advised on the Alico purchase by Credit Suisse Group, Barclays Capital, Bank of America Merrill Lynch,
HSBC Holdings
PLC and
Deutsche Bank AG
. AIG's advisers included Goldman Sachs Group Inc., Citigroup Inc. and Blackstone Group LP. Morgan Stanley advised the New York Fed, which will get the first $9 billion in cash proceeds from the Alico sale.

Back in March 2009, when AIG incurred a record $99.3 billion annual loss for 2008 and it was being offered only fire-sale prices for its assets, the New York Fed made a big bet that market conditions would improve enough to enable AIG's two large foreign insurance businesses to be sold or spun off via initial public offerings sometime in 2010.

To help ease AIG's debt burden last year, the regional Fed bank forgave a $25 billion portion of its loan to AIG and acquired preferred equity in Alico and AIA, its two crown-jewel assets.

The New York Fed is now in line to receive the first $9 billion in cash proceeds from the sale of Alico and $16 billion from the AIA sale when both deals close.

AIG will also be able to reduce some of its outstanding $25.1 billion Fed debt with additional cash from the AIA sale. The rest is to be paid down before the credit facility expires in September 2013, as AIG sells off its stakes in Prudential and MetLife.

AIG, meanwhile, needs to overcome several hurdles before it can operate on its own without financial support from the government. For example, since the crisis AIG and its subsidiaries haven't been able to issue unsecured bonds to fund themselves or refinance maturing debt. Two of its units, ILFC and consumer lender American General Finance, are now trying to work out their funding challenges by issuing new long-term debt secured by assets such as aircraft leases and home loans.

For AIG to realize its plan of repaying taxpayers and emerging from government ownership, "the markets need to remain more or less stable to positive over a sustained period of time," wrote David Havens, a managing director at Nomura Securities, in a note last week.